What is a testamentary trust?
A testamentary trust can only be established for your beneficiaries by your Will after you die.
The purpose of these special trusts is to remove the need for a beneficiary to own their inheritance in their own name, which protects their inheritance from third parties - such as during a beneficiary's divorce, de facto breakup, business failure or bankruptcy.
As most beneficiaries act as the trustee of their own trust(s), they still use and manage their inheritance as they normally would.
Testamentary trusts are an extremely popular, simple, inexpensive and effective strategy to protect inherited wealth. Given the likelihood of a loved one having financial or relationship troubles at some point during their life, the asset protection and tax benefits of testamentary trusts make them a sensible inclusion in every Will.
An easy way to think about a testamentary trust is as an 'imaginary bank' or legal arrangement that exists only on paper to help minimise tax & protect a beneficiary’s inherited assets when under threat from third parties.
What is the difference between a testamentary trust & a Will?
A testamentary trust is not a Will. However, a Will is the only way to create a testamentary trust.
A testamentary trust is simply a type of trust that can only be created by a Will that includes the required testamentary trust provisions and terms.
A testamentary trust can only come into effect following the death of a Will owner and once probate is granted authorising the executor to distribute the estate to the nominated beneficiaries.
Beneficiaries are then given the option to receive their inheritance in a testamentary trust or not.
Testamentary trusts should be discretionary (i.e. beneficiaries control their trust), individual (i.e. beneficiaries each have their own trust) and optional (i.e. beneficiaries choose whether to use the trust or not).
Do all Wills provide beneficiaries with testamentary trusts?
No. Only Wills that include the required provisions and terms provide testamentary trusts.
Will Wizard's testamentary trust terms are found in Segment 3 of our Wills. These trust terms form 13 pages of our 30 page Wills.
Our trust terms provide beneficiaries with the flexibility they need to manage their inherited wealth long term, depending on their changing circumstances, wishes and tax status.
How do you create a testamentary trust?
A testamentary trust can only be created if the appropriate legal provisions and terms are included in the Will.
Beneficiaries lucky enough to receive their inheritance in a testamentary trust should seek the advice of a professional accountant or solicitor with experience in the establishment and management of testamentary trusts.
An accountant or solicitor would review the terms of trusts in the Will and explain the process to set up each testamentary trust.
They would provide detailed advice on what assets should go into a testamentary trust, along with the appropriate minutes to establish a testamentary trust.
They would assist you in applying for a TFN, and provide advice on the naming conventions, along with formal instructions detailing what your obligations and next steps are.
Once set up, it becomes a simple matter of submitting a tax return each year for your trust.
What is the purpose of a testamentary trust?
There are two main purposes of a testamentary trust.
The first is to provide beneficiaries with opportunities to minimise the income tax and capital gains tax burden on inherited wealth.
The second is to protect inherited wealth from third party threats such as during a divorce, de facto break-up or financial troubles such as a business failure or bankruptcy.
Why do I need a testamentary trust?
It is highly advantageous to receive an inheritance in a testamentary trust as such trusts created by an Australian Will have special powers under Australian law that substantially protect inherited wealth from family law settlements and bankruptcy.
Testamentary trusts also provide beneficiaries with valuable opportunities to minimise the tax burden on inherited wealth by allowing income earned from the trust to be shared amongst family members on lower tax rates.
These protections and tax benefits can last for 80 years, and testamentary trusts can be transferred across generations, which preserves these advantages for your children and grandchildren.
Can you set up your own testamentary trust in Australia?
So long as the Will you are inheriting by includes provisions for the establishment of a testamentary trust.
However, without the proper expertise, it would be a difficult process.
We would always recommend seeking the advice of a professional accountant or solicitor who has experience in the establishment and management of testamentary trusts.
An accountant or solicitor would review the terms of trusts in the Will and explain the process to set up each testamentary trust. They would provide detailed advice on what assets should go into a testamentary trust, along with the appropriate minutes to establish a testamentary trust. They would assist you in applying for a TFN, and provide advice on the naming conventions, along with formal instructions detailing what your obligations and next steps are.
How does a testamentary trust work?
Following your death, your executor will seek the assistance of a solicitor with applying for Probate.
Once Probate has been granted, your executor is able to distribute your estate to your beneficiaries.
If your Will allows for testamentary trusts to be established for beneficiaries, your executor will seek further assistance from their solicitor and/or accountant in establishing the trusts for your beneficiaries.
An accountant or solicitor would review the terms of trusts in the Will and explain the process to set up each testamentary trust.
They would provide detailed advice on what assets should go into a testamentary trust, along with the appropriate minutes to establish a testamentary trust. They would assist your executor in applying for a TFN, and provide advice on the naming conventions, along with formal instructions detailing what the beneficiary's obligations and next steps are. The cost of establishing a testamentary trust is minimal.
A testamentary trust acts as a financial entity, and so a tax return is required to be filed each year. This is usually handled by the beneficiary's accountant, with the cost associated with running a testamentary trust running from a few hundred dollars per year up to several thousand depending on how complicated the beneficiary's needs and circumstances are, which dictates the work required by your accountant.
However, these running costs usually pale in comparison with the tax saved or with the value of protecting inheritances long term.
Will Wizard ensures that beneficiaries can choose which inherited assets they wish to receive into their testamentary trust, whether they want to have multiple testamentary trusts, whether they want to alter the terms of their trust, or whether to have a trust at all.
Beneficiaries usually choose to be the trustee (i.e. the controller or manager) of their own trust.
All Wills from Will Wizard allows the Will owner to nominate a ‘controlling age’ that beneficiaries must obtain before they can act as the trustee of their own trust.
Prior to reaching the controlling age, the executor acts as the trustee on behalf of the young beneficiary. Beneficiaries under the controlling age still have access to funds for health, education, living and welfare purposes, but are prevented from spending their inheritance on immature purchases.
Who gets a testamentary trust?
Will Wizard provides every beneficiary, including the bloodline lineal descendants of beneficiaries (i.e. children, grandchildren & so on), with the option to inherit via a testamentary trust that they personally control as trustee (unless they choose a third party trustee).
The terms (or rules) of our testamentary trusts are very broad to give beneficiaries complete flexibility in how they manage their trust over time depending on their changing needs, wishes and tax status.
Most importantly, our testamentary trusts are for the benefit of the primary beneficiary only, unless the primary beneficiary gives expressed consent for others to benefit from the trust.
What are the different types of testamentary trust?
The ‘type’ of trust simply refers to the trust terms that govern how the trust is to be managed.
These terms differ from Will to Will.
The type of trust that might best suit a primary beneficiary given their circumstances and given the various tax and other laws that may or may not impact their inheritance in the future is impossible to predict.
As such, Wills from Will Wizard provides examples of different types of trust options possible, giving executors & beneficiaries the discretion to vary the terms of trust so that each beneficiary can choose the type of trust that best suits their needs and circumstances.
Examples of different trust options possible are listed below (this list is in no way exhaustive):
Superannuation Death Benefits Trust;
Parallel Testamentary Trusts;
Amalgamated Testamentary Trusts;
Restricted Testamentary Trusts;
Preservation Trusts For Beneficiaries Under The Controlling Age;
Split fixed Testamentary Trusts.
What are the benefits of a testamentary trust?
Testamentary trusts are widely recommended by Australian lawyers because they are inexpensive to run but provide extremely valuable asset protection and tax minimisation opportunities to beneficiaries.
Inheritance Protected From Family Law Claims
Testamentary trusts provide protection for a beneficiary who is experiencing family law difficulties. With the inheritance held in a testamentary trust, the primary beneficiary can isolate inherited assets from personal assets. This helps to protect their inheritance from family law property proceedings following a divorce or a de facto break-up.
Inheritance Protected From Bankruptcy
Testamentary trusts provide protection to your beneficiaries from the repercussions of bankruptcy.
Assets that pass to a testamentary trust from an estate are held for the nominated primary beneficiary until the trustee elects to distribute such assets. At law the assets are not owned personally by the beneficiary and therefore do not form part of the beneficiary’s personal estate. A creditor or other person claiming against the beneficiary, therefore, cannot obtain the assets held in the trust.
Significant Income Tax Savings For Beneficiaries
Testamentary trusts give a beneficiary the option to reduce personal income tax by splitting income from the investment of the inheritance between a range of family members on low tax rates. The trustee of the testamentary trust (normally the primary beneficiary) has complete discretion to determine who receives the income of the trust. Tax is paid on the income of the trust at the marginal tax rate of the beneficiaries who receive it.
Therefore, by selecting beneficiaries on low marginal tax rates, the trustee can minimise the taxation liability of the trust. The trustee can choose to distribute income to minor beneficiaries of the trust with each beneficiary being able to receive over $18,200 of income tax-free to pay for education and living expenses.
For a one million dollar estate that is invested for a modest 5% return, this equates to $50,000 income per year, which if distributed among children or low income family members could equate over ten years to half a million dollars tax saved for the benefit of your family rather than the ATO.
Significant Capital Gains Tax Savings For Beneficiaries.
Testamentary trusts also provide the opportunity for beneficiaries to minimise Capital Gains Tax which arises from the sale of assets. Capital Gains Tax is not triggered when an asset belonging to you passes via your Will to your executor or the trustee of a testamentary trust. Also, there is no Capital Gains Tax when your assets are transferred from the trustee of a testamentary trust to a beneficiary. As with the income of the trust, the trustee can select which of the beneficiaries of the testamentary trust should take the capital gain.
By choosing to distribute the capital gain to a beneficiary on a low or nil income, the capital gains tax liability can be significantly reduced. Holding the assets of an estate within a trust offers the beneficiaries an opportunity to defer the need for the sale of assets (and therefore capital gains tax) until later when more numerous beneficiaries come into existence. Tax deferred is tax saved.
Normally penalty rates of tax apply to income derived from trusts which is paid to children under age 18. The Tax Act allows children under age 18 who receive income from a testamentary trust to be treated as adults for tax purposes. This could mean significant tax savings for beneficiaries who can “split income” with their minor children. Over 10 years this could be mean hundreds of thousands of dollars for your family rather than the ATO.
Testamentary trusts substantially protect inherited wealth from a host of common problems and circumstances that lead to inherited wealth being lost, confiscated and wasted, such as;
A de facto relationship breakdown;
Being sued professionally;
A business failure;
Debts to creditors;
Other money problems;
A mental health issue;
A drug or gambling addiction.
Testamentary trusts also provides opportunities to:
Minimise Income Tax;
Minimise Capital Gains Tax;
These extremely valuable protections and financial advantages can last for 80 years. Testamentary trusts are also able to be passed across generations creating a long term protected financial legacy for your family. Testamentary Trusts are how smart Aussie families keep their wealth in the family.
Can a testamentary trust be contested?
Inherited assets held in a testamentary trust can be contested by a person with a legitimate claim to your estate (i.e. a financial dependent such as a spouse, de facto partner, a child from a previous relationship etc).
Therefore it is crucial to ensure that your Will adequately provide for those people with a legal claim to your estate.
If you are unsure about who you need to include in your Will as a beneficiary, please seek independent legal advice.
What are the disadvantages of a testamentary trust?
A beneficiary should always seek profession advice from an accountant or solicitor about whether a testamentary trust is right for them given their needs and circumstances.
For instance it may not make sense for a beneficiary to have a testamentary trust if they live overseas.
In most cases the many asset protection and tax advantages provided by testamentary trusts far outweigh the disadvantages.
Most websites will refer to the annual accounting costs as the only disadvantage. But these costs are usually only a few hundred dollars per year (up to several thousand in complex cases), which pales in comparison the taxes that can saved and the value of the long term asset protections provided by testamentary trusts.
How does a testamentary trust protect assets?
Testamentary trusts provide protection for a beneficiary who is experiencing family law difficulties.
With the inheritance held in a testamentary trust, the primary beneficiary can isolate inherited assets from personal assets.
This helps to protect their inheritance from family law property proceedings following a divorce or a de facto break-up. Assets held in a testamentary trust are considered privileged and not part of the asset pool that is up for grabs.
Testamentary trusts also provide protection to your beneficiaries from the repercussions of bankruptcy.
Assets that pass to a testamentary trust from an estate are held for the nominated primary beneficiary until the trustee elects to distribute such assets.
At law the assets are not owned personally by the beneficiary and therefore do not form part of the beneficiary’s personal estate. A creditor or other person claiming against the beneficiary, therefore, cannot obtain the assets held in the trust.